Joseph Stiglitz: “it may be necessary to abandon the euro to save the European project.” Markus Brunnermeier: “the situation is improving. The structural reforms really worked, and made a huge difference.”
With Italy’s referendum on constitutional reform less than a week away, economists and analysts are once again worried about a possible break up of the euro. A loss for Italy’s prime minister Matteo Renzi in Sunday’s vote could reignite the euro crisis and jeopardize the survival of the single currency—but even if Renzi prevails, with a looming banking crisis on the horizon and an ongoing populist revolt, several economists are contending that the euro may in fact be already doomed.
Can the euro be saved, or are the obstacles presented by European politics simply too big to allow implementation of crucial reform? Yesterday (November 30, 2016), a Stigler Center panel between economists Joseph Stiglitz and Markus Brunnermeier pitted skepticism versus optimism regarding the euro’s survival, touching upon issues such as the structure of the single currency, the opposing economic philosophies of Germany and France, and the rise of populism. (You can watch a video of the panel here) .
Stiglitz and Brunnermeier are both authors of recent books on the euro crisis: Stigliz, a Nobel laureate, is the author of The Euro: How a Common Currency Threatens the Future of Europe (W. W. Norton, 2016). Brunnermeier is the co-author of The Euro and the Battle of Ideas (Princeton University Press, 2016), along with Harold James and Jean-Pierre Landau. The panel was moderated by Luigi Zingales, a professor at the University of Chicago Booth School of Business (also, one of the editors of this blog), and the author of Europa o No (Rizzoli, 2014; Italian).
Stiglitz, who in his new book argues that the euro’s faults outweigh its benefits, began by describing the euro as “a political project, not an economic one.” The financial crisis of 2008, Stiglitz said, compounded the conditions that led to the euro crisis, allowing the flaws in the euro’s design to be manifested: “you might say it was bad luck, if there hadn’t been any crisis, things might have gone on longer before the weaknesses that I think were inevitable showed up.”
Stiglitz went on to offer a more pessimistic take, suggesting that Europe may not be able to build the institutions needed to save the single currency. “I really think the idea of a European project, bringing the countries of Europe together, was very important. In many areas, Europe has been a beacon for human rights and for climate change, so having a working Europe is really important, not only for Europe, but for the world. What I worry about is that because of this flawed currency arrangement, it won’t be able to fulfill those roles.”
Europe, said Stiglitz, may have to abandon the euro altogether. “There either has to be more Europe—completing the institutions that are required to make a single currency work—or less Europe: an amicable divorce introducing some more flexibility. If you ask me which direction [is more likely], I am not very hopeful about the first. The bottom line, in a sense, is that it may be necessary to abandon the euro to save the European project. Currency arrangements come and go. My view is that the best thing would be to fix it, but if you can’t fix it, just move on.”
Brunnermeier, who argues in his book that the euro crisis is largely driven by a clash between the economic philosophies of Germany and France, offered a far more optimistic view of the crisis. Contrary to popular belief, he said, many required reforms have already been made. “Why are we optimistic? One should look at what happened since 2010. Many measures were put in place which were unimaginable before then. Just look at the banking sector, where all the big banks are now regulated by the Europeans. That makes a huge change. Essentially, what happened with the national regulators is that they became defenders of their banks against the Europeans. Now, big banks are regulated by the Europeans, who have more control over this, and it becomes much less problematic.”
Nevertheless, he said, Germany and France have a “Rhine divide” between them when it comes to fixing the euro. The Germans prefer a rule-based approach that emphasizes ex-ante rather than ex-post interventions, while the French prefer a discretion-based approach that emphasizes active crisis management and “ad hoc measures that the Germans frown upon.” The French, added Brunnermeier, believe in solidarity, while the Germans idolize the principle of liability and “are very concerned that a fiscal union would immediately translate into a transfer union.” France believes the crisis is a crisis of liquidity, while Germany believes the crisis revolves around issues of solvency.
“We are at a critical phase, but shooting down [the euro] would be a huge step backwards,” said Brunnermeier. “My confidence comes from the fact that so many steps were taken.”
While both panelists agreed that this is a crucial time for the euro’s survival, they differed in their analyses of the current state of crisis countries. “The situation is improving. Spain is growing nicely. Spain has turned itself around. Ireland is growing phenomenally. There are successful examples in Europe as well: the structural reforms really worked, and made a huge difference,” said Brunnermeier.
Stiglitz disagreed. “Ireland is fantastic: its GDP grew by 26 percent last year. If you believe that, then I have a bridge in Brooklyn to sell you. It’s not real GDP. It’s based on tax avoidance and a business model that is robbing other countries. You talk to people in Ireland, they don’t feel an increase in their standards of living.”
Both panelists, however, agreed with Brunnermeier’s thesis that the European crisis has to be examined through the lens of ideas, not just interests. “Ideas, particularly ideas about what would make an economy work, were very influential in the construction of the euro in 1992,” said Stiglitz. “I think if it had been done now, after the East Asian crisis and the global financial crisis, the rules would have been written in a very different way. There would not have been as blind a faith that markets would take care of most of the things, so long as governments kept deficits and debts low and as long as inflation was kept low.”
Nevertheless, Stiglitz expressed “a very strong sense of pessimism” regarding the chances that economic and ideological divergences that characterized the years since the creation of the euro can be reconciled anytime soon. “In 1992 there were large differences in beliefs, but the increase in disparity in the economy has increased the disparity of beliefs. And so the conclusion I get out of this is that it’s going to be even more difficult to make the euro work.”
Remedies: deposit insurance vs. “ESBies”
In debating possible remedies for the crisis, Stiglitz and Brunnermeier disagreed on the level and nature of political and economic integration necessary for the euro to work.
Arguing that measures taken since 2010 were “much too little and typically too late,” Stiglitz was more critical of the European response to the crisis, arguing that further political and economic integration is necessary for the euro to work. “There have been some big steps, but is it bigger than anticipated? When I’ve discussed this in Europe with [Jeroen] Dijsselbloem, head of the finance ministers’ group, he said America passed its National Bank Act in 1863, and it took us a long time to get everything working, and still it’s not working well. ‘So just give us 100 years or so. The glass may not be half full, it may be 99 percent empty, but that means it is still 1 percent full and that gives us hope.’”
He added: “what worries me is that the some of these halfway [measures] are worse than nothing. For instance, they’ve talked about a banking union, the kind of framework that in the United States took a long time: common supervision, common resolution, and common deposit insurance. The most important to preventing the divergence of the eurozone is common deposit insurance, and yet the response of Germany is ‘we agree in principle, but not yet.’”
Stiglitz argued that some form of risk-sharing, even if at a lower level than that of American states, is necessary for the euro to work. “Common supervision can actually be bad without common deposit insurance. If you don’t have common deposit insurance and common resolution, then uniform rules without sensitivity to the situation of each country and the need to have forbearing can actually make things worse.”
Brunnermeier countered that some forms of risk-sharing already exist within Europe. “Since the European Stability Mechanism and other mechanisms were put in place, huge transfers were made behind the scenes. It’s not fair to say that there is no risk-sharing in Europe.” However, he said, “Germans put a lot of emphasis on the political economy. What they don’t want is to end up with something like Italy, where the north is supporting the south. That is not going well. Having a productive core, where all the productive people move to the core and produce there, and the periphery is supported by the core—that’s not a vision of how Europe should work in the long-run.”
Brunnermeier advocated the creation of pan-European safe bonds, or “ESBies” as a possible tool for bridging the political and economic divide. “It would not solve all the problems, but it would solve two problems. It would switch off the ‘diabolic loop’ or nexus between sovereign and bank credit risk, and it would prevent flights to safety from going across borders. At the moment, Germany has a monopoly on the safe assets: whenever the crisis becomes more severe, than the flight to safety runs across borders, out of the periphery and into Germany. In this new framework, it would not run across borders but from one European entity to another European entity.”
Both participants devoted special attention to one of the watershed moments of the euro crisis: the 2013 financial crisis in Cyprus, which was credited with shifting the European handling of the crisis from a bailout-led approach to an approach that focuses on “bail-in”—that is, the rescue of financial institutions by imposing losses on creditors and depositors. Brunnermeier said the Cyprus crisis was an example of the chasm between the French and German approaches.
“The Germans said ‘if Cyprus is systemic, then everything is systemic, so we have to stand our ground.’ In Cyprus, most of the banks were holding money from Russian oligarchs, black money, and the Germans refused to use European taxpayers’ money to bailout Russian oligarchs. This shifted the whole emphasis from bailouts to bail-ins, and established this new bail-in regime that Italy is currently suffering from,” said Brunnermeier.
Stiglitz countered that the behavior of European leaders during the Cyprus crisis exacerbated the crisis. “The position that was taken at one point—and eventually reversed—was that depositors would be bailed in and suffer a loss. That to me was a really bad decision, even if it were Russian oligarchs that had deposits there. The same thing effectively happened in Greece, but in a different form. The reason I worry about that is that it sends a very strong signal that if you keep your money in banks in one of these countries where there is the possibility of a problem, you may lose your money. What does a rational individual do? He takes the money out. In a sense, Europe has introduced an incentive for a run against the banks. The only way to stop that is to have a European-wide deposit insurance.”
Stiglitz went on to say that European leaders have “created an environment where there is ambiguity and in which there is significant risk of a run.” He added: “The policies that they pursued in Greece and in Cyprus made it even more imperative to have this kind of European-wide deposit insurance quickly, and they have not done that, and that is why I think things are worse today than when the crisis started in 2010.”
The rise of populism
While both panelists expressed concerns regarding the rise of populist politics in Europe, Stiglitz’s analysis was far bleaker. “The issue of populism all over Europe is one of the concerns that I have about the viability of the eurozone. Earlier on I was joking about European leaders saying ‘give us more time,’ but the question is whether the politics and the populist movements will give you time. You can’t say ‘we’ve had youth unemployment of 40 percent for a decade, take another decade and we’ll fix it.’ That’s not likely to happen. My concern is that there there’s a clock ticking, presented by populist movements and in some countries separatist movements.”
Stiglitz added: “The center which held Europe together and was at the core of the success of the European project, that is fraying. The disconnect between the speed at which the reforms are occurring and the disillusion of large number of voters, exacerbated by other things like migration which have not helped, means that I’m not sure there’s going to enough time to muddle through.”
Brunnermeier, however, ended on a more optimistic note. “I agree that support is eroding for the whole European project, but on the hand we saw after the Brexit vote that support for Europe actually went up significantly in Germany and many other core countries. I think people suddenly realized what they have–free movement, and the ability to live and work in any country within Europe—and the popularity of the European Union went up.”
Brunnermeier added: “what one has to keep in mind is that things can change very radically again. Imagine that something happens with the Eastern front. Suddenly people will realize how important Europe is, for the Europeans but also for the rest of the world as well. You see it already, with Trump saying he will put less military defense into Europe. At the moment we are at a critical juncture, and the mood is changing in a negative way—in Germany as well, to some extent. But I think there is still strong support to hold this thing together, and I think people underestimate how strong these forces are. The alternative will be much, much worse. It’s difficult to argue these days that rational economic reasoning prevails at the end of the day, but that’s what makes me hopeful and confident that things will hold together.”